President Barack Obama said he is "modestly optimistic" that a deal
will be reached that prevents a blitz of tax rises and spending cuts hitting
the US economy next week.

The guarded optimism from The White House came just hours after Wall Street closed sharply lower on fears Congress will fail to prevent the American economy falling over the fiscal cliff, the shorthand for $600bn (£372) of tax rises and spending cuts that take effect from January 1.

"The hour for immediate action is here. It is now," Mr Obama said after meeting with Democratic and Republican leaders in Congress. "Americans will not have any patience for a self-inflicted wound on the economy."

Investors around the world are have tracked the tortuous negotiations in Washington as politicians fight over how to cut America's $16.4 trillion of debt without choking off a recovery in the world's largest economy.

“The average investor – indeed, the average citizen – would like to see Congress pivot to long-term co-operative solutions, and away from continuous bickering and recurrent dithering,” said Mohamed El-Erian, the chief executive of Pimco, the world’s largest bond investor.

Should all the tax increases and roughly $100bn of spending cuts – which also take effect from January – be allowed to happen, most economists fear the US will plunge back into recession in the first quarter of 2013. The cautious confidence from President Obama was echoed by Mitch McConnell, the leader of the Republicans in the Senate, and Harry Reid, who heads the majority Democratic faction.

The two men said they will work over the next 24 hours to reach a deal that the Senate can vote on on Sunday. Should a deal pass the Senate, it would then need to be voted on by the Republican-controlled House of Representatives.

A last-ditch accord will need both sides to reach a compromise on which Americans should pay higher taxes next year, after reductions first introduced by George W Bush expire on Monday. Tax rates are proving the toughest sticking point between Republicans and Democrats, with the former insisting that only those households with annual income above $1m should have to pay more.

Although investors are braced for a stomach-churning day on Monday, economists say the potential economic damage could be limited should the deadline lapse. Those politicians who were elected to Congress in November take office on January 3, and the new Congress is expected to quickly strike a deal on the fiscal cliff if the current incumbents fail.

However, the longer the stalemate lasts, the greater the damage that will be inflicted on consumers and businesses. “The longer our politicians maintain their extreme polarisation and paralysis, the greater the impact on consumer confidence and on the willingness of companies to invest,” said Mr El-Erian.

The Dow Jones Industrial Average closed down 1.2pc at 12,938.10 on Wall Street. The FTSE 100 earlier finished 0.5pc lower at 5,925.37.

The Telegraph Investor

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